Types of investments: What you Should Know
What are the different types of investments?
People who are preparing to invest need to understand the different types of investments that are available. There are many different types of investments that fall into broad categories, including the following:
- Investment funds
- Retirement accounts
- Ownership investments
- Alternative investments
Statistics can help to show important aspects about many types of investments. Despite the Great Depression and numerous crashes and corrections, the stock market has increased 1,100-fold over the past seven decades. When workers were asked how much they had saved for retirement, more than half reported that they had amassed less than $25,000.
Index funds for example, are the investments that often outperform actively managed mutual funds. 80 percent of large-cap funds over a 10-year period were outperformed by the S&P 500. Finally, dividend stocks have an average of 4 percent higher returns. If you reinvest your dividends, your investments have the opportunity to grow much faster.
The important takeaways from these statistics are that you should begin saving as early as possible and be particular about the types of investments that you choose. It is also a good idea to avoid active day trading and to try to avoid emotional reactions to fluctuations in the market.
What are some investment strategies and investment options?
Having an investment strategy is important because it can serve as a guide for you as you build your portfolio. While there are many investment strategies out there, a few popular strategies include the following:
- Value investing or finding stocks that are undervalued and buying them
- Growth investing or searching for companies to invest in that have above-average growth
- Income investing or choosing investments that pay out money over time on a regular schedule
- Small cap investing or buying stocks in companies that have smaller market capitalizations
Value investing was popularized by Warren Buffett and requires a sound understanding of the fundamentals of companies. Growth investing involves some research and looks for companies that demonstrate signs that they will enjoy above-average growth.
Income investing is purchasing securities that pay regular returns on a schedule, including investment options such as bonds, exchange-traded funds, stocks that pay dividends, REITs, and mutual funds. Small cap investing is a strategy that carries a higher risk because you invest in smaller companies that tend to experience more volatility.
Types of investments and their pros and cons
Now that you have a general idea of some different investment strategies, it is good to take a closer look at some of the investment options and types of investments that are available. Each of these types of investments has pros and cons and understanding what they are can help to guide your decision-making process when you are considering your investment options.
Your stocks: Two categories
When you are thinking about your stocks and what you should choose, there are two primary types of investments in this investment options category, including common and preferred stocks. Common stocks are shares of companies that provide you with voting rights at shareholders’ meetings.
If you choose these types of investments for your stocks, you can earn profits through dividends and rising share prices. The dividends will vary, and common stockholders are the last in line to recoup their investments in the event that the companies go bankrupt.
Preferred stocks operate in a different way. They are also shares of a company, but they pay dividends in predetermined amounts. If you are a preferred stockholder, you may not have voting rights.
However, you will have priority over common stockholders in the company if it declares bankruptcy. The dividends that are paid to preferred stockholders are generally larger than the dividends that are paid to common stockholders.
Bonds are securities that are considered to be lower-risk types of investments, but the risk varies based on the credit profile of the bond issuer. They allow others to borrow money from you. Bonds pay you a fixed interest rate, and the debt that is owed to you by the government or corporate entity is repaid when your security matures. There are several types of bonds, including the following:
- Corporate – Securities that are issued by corporations to raise money for financing
- Municipal – Securities that are issued by city governments to raise money for projects
- U.S. Treasury securities – Debt securities with long-term maturities of more than 10 years
- U.S. savings bonds – Long-term U.S. bonds with relatively little risk
There are several different types of investments in the funds category, including mutual, exchange-traded, and index funds. Each of these different investment options has its own benefits and disadvantages.
Mutual funds are funds in which you are invested in many different companies simultaneously. These types of funds help you to lessen the risks that you would face by investing in shares in a single company or a limited number of companies. These funds may include investments in large, stable companies as well as newer businesses that are quickly growing.
These funds are managed by a team, and you give up your control to the team of money managers. Some funds charge fees for all of the purchases, and most charge annual fees.
An exchange-traded fund is also known as an ETF. ETFs are types of investments that are a group of stocks and allow you to pool your money. ETF stocks trade on the market like other types of stock. There are generally no managers involved, so these funds have lower fees and let you trade easily and frequently.
Index funds are investments that are meant to track a particular asset class. The portfolio of an index fund is built to track different indexes such as the S&P 500. These funds offer broad exposure to the market and lower fees and are passive types of investments.
Stock options are not actually investments in stock securities. Instead, they are contracts that allow you to exercise the option to purchase or sell stocks at a set price on a specific date.
When you purchase an option, you are purchasing the contract for the choice to buy or sell. You can exercise your contract or choose to let it expire. People make money with these types of investments by getting a fixed price at which they can buy or sell and betting that the securities will either increase in value or fall in value by the specified date.
Retirement accounts are other investment options that can help you to save money for when you retire over a long period of time. Some of these accounts are tax-advantaged and allow you to make contributions on a pre-tax basis while others allow you to make contributions after tax and then to make withdrawals in retirement that are tax-free. The two primary categories of retirement accounts include 401(k) accounts and IRAs. There are multiple types of IRAs, including the following:
- Traditional IRAs
- SEP IRAs
- SIMPLE IRAs
- Roth IRAs
- Inherited IRAs
A 401(k) account is an employer-sponsored plan that allows you to contribute money on a pre-tax basis. A 401(k) vs. IRA has higher annual contribution limits. You are able to contribute up to $19,000 per year through deferrals from your salary. Your employer can choose to offer matching contributions or to forgo them. If you are older than age 50, you are allowed to make catch-up contributions of an additional $6,000 per year for a total of $25,000.
IRAs are individual retirement accounts that you can establish on your own. The two main types of IRAs include Roth accounts and traditional accounts. Traditional and Roth accounts both have annual contribution limits of $6,000 per year if you are younger than 50, and $7,000 per year if you are age 50 or older.
When you compare a traditional IRA vs. 401(k), both types of accounts allow you to make contributions on a pre-tax basis. This allows your money to grow tax-deferred until you retire. However, an IRA vs. 401(k) may offer you more investment choices. A 401(k) vs. IRA may offer limited investment options from which to choose.
Both a 401(k) and a traditional IRA have required minimum distributions once you reach age 70 1/2. You will also have to pay early withdrawal penalties if you make withdrawals before you reach age 59 1/2 and pay taxes on your withdrawals after you retire.
Roth IRAs are different because you make contributions after tax. Your money grows tax-free, and there is not a required minimum distribution. With a Roth, you can contribute as long as you want while you are unable to continue contributing to a traditional account or a 401(k) after you reach age 70 1/2.
Ownership – Real estate investment and home
Some people choose to invest in property like real estate and their homes. Real estate ownership might include purchasing homes to fix and flip or rentals that you can rent out to others.
When you purchase homes or properties to rent out or sell, they are investments. You should not consider your own home to be an investment, however. Instead, it fills your need for shelter and should not be treated as something that you expect to reap profits.
The final category of investments is alternative investments. These include the following:
- REIT stocks
- Commodities and futures
- Precious metals
- Hedge funds and private equity
Real estate investment trusts or REITs are companies that invest in real estate that produces income across a variety of different types of property sectors. To qualify as a real estate investment trust, a company must meet multiple requirements. A real estate investment trust is traded on the stock exchange.
Commodities allow you to invest in products and materials that can be bought and sold such as coffee, other agricultural products, gold, silver, and others. There are four ways for how to invest in commodities, including the following:
- Direct investments
- Commodity futures contracts
- Purchasing shares of companies that produce a commodity
- Purchasing shares of an exchange-trade fund that invests in commodities
Investing in commodities can take some education but doing so can have a positive impact on your returns.
Hedge funds can invest in nearly anything, including currencies, real estate, land, derivatives, and other investments. It is common for a hedge fund to rely on borrowed money in an attempt to increase its returns.
Private equity refers to investments in private companies such as startups. Funds are invested with private equity firms that invest the money with private companies that they believe are promising. A subset of this category is real estate private equity. This includes pooled investments in property.
Precious metals such as gold, silver, platinum, and palladium can all serve as alternative investments. You can purchase gold bonds or gold stocks. In addition to bonds and gold stocks, you can also invest in gold and other precious metals by purchasing bars.
You also have the option of investing in a precious metals ETF for greater diversification. Regardless of whether you directly invest in metals or invest in a precious metals ETF, the value of these types of investments tends to increase when times are uncertain and fall when they are more stable.
Portfolios and diversification strategy
What is a portfolio? Your portfolio is the different securities and investments that you have chosen to meet your investment goals and strategies. Your portfolio includes a variety of different types of asset classes.
What are assets? Your assets are the individual investments that you have chosen. The assets that you choose are important and should be carefully researched so that you can maximize your earnings. It is best for you to choose a diversification strategy that can maximize your earnings without over-diversification.
Overall financial plan and strategy
It is important for you to begin your journey toward reaching your financial goals by writing your overall financial plan and determining the strategy that you want to follow. Your financial plan and investment strategy should serve as a guide to creating your portfolio.
If you have a good plan and are able to avoid emotional reactions, you can potentially realize substantial earnings through your investments. It is important for you to review your plan and your strategy on at least an annual basis so that you can make modifications where they might be needed.
How to diversify with investments
There are several ways to diversify with your investments, including the following:
- Spread your money across multiple investments
- Think about investing in stock and bond funds
- Continue building with dollar-cost averaging
- Buy and hold, but also know when you should make an exit
- Watch out for commissions
How investing with the M1 Finance investment platform works
M1 Finance is a firm that offers a smart investment platform. The company combines innovative expertise together with advanced technology to help to automate the investment process. You are able to choose from a broad variety of securities and multiple types of accounts.
M1 Finance allows you to choose your own investments or to pick a portfolio that has been created by experts. You can decide the percentages that you want to assign to each investment in your portfolio and sit back and watch them grow. Automatic funds transfers can be set up so that you can remove the temptation of having money available to you that you might otherwise spend.
M1 Finance benefits
M1 Finance does not charge commissions or management fees. This allows your money the opportunity to grow even more. You can enjoy accessibility as well as the ability to choose the types of account and investments that meet your goals.